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Q&A | Are debt-ridden Canadians facing a housing bubble?

Bank of Canada Governor Stephen Poloz has warned of a housing bubble whereby Canadian homes may be overvalued by up to 30 per cent – possibly more in hot housing markets like Vancouver and Toronto.

With Canada’s economy slowing and Canadian household debt increasing, the impact of a price correction could be severe, says Thomas Davidoff, Assistant Professor in Sauder’s Strategy and Business Economics Division.

Do you agree with Stephen Poloz that Canadians may face a housing bubble as large as 30 per cent?

I agree that prices in cities like Vancouver could fall by as much as 30 per cent. But I also agree that it's very difficult to forecast home prices, particularly in cities like Vancouver. A large fraction of the value of homes near Vancouver consists of peoples' willingness to pay to live here, and that can fluctuate a lot. For Canadians who own homes, they hold a risky asset. They have enjoyed a tremendous increase in wealth, but a lot of their wealth is at risk. For households waiting for better affordability before buying, falling prices would be good news. But for households likely to continue renting, overvaluation does not mean much. Yet a price crash could trigger a recession, as home equity withdrawals through refinancing have likely helped stave off recession the last five or so years.

Canadian household debt-to-income ratios have seen the largest increase from 2007 to 2014, behind only Greece. Should Canadians be wary of this?

Yes, interest rates can rise, which would increase debt costs. Combine that with a scenario in which prices fall 20 per cent or so due to the bubble bursting, and you have some consumers in a tough spot, unable to sell their homes and pay off all their debts. The Canadian government is potentially on the hook for a significant amount of money if prices collapse and large numbers of over-extended households go bad on their debts.

How do the rising Canadian household debt levels affect any concerns for the market?

If households become less wealthy because home values fall, bad things can happen. But the really bad thing is if the lenders start to lose lots of money. The first place to lose money would be the Canada Mortgage and Housing Corporation, which guarantees a lot of the risky loans the banks made. As for affordability in Vancouver, the costs are sky-high, but rents actually aren’t that bad here. If you want to think of affordability, we shouldn’t be so worried if people can’t buy, but we should be worried if people can’t rent.

The Central Bank has dropped its interest rate from 1.0 per cent to 0.75 per cent but individual banks have been slow to follow, so what effect will this have for Canadian consumers?

Lower interest rates are thought to increase housing prices, and the real reason has to do with affordability. A lot of people who are buying a house just barely qualify for a loan because their income isn’t high enough to support a payment. Lowering interest rates on mortgages softens that payment constraint, which could drive up prices. Now, something interesting we’ve seen is that some banks have been slow to lower interest rates. The central bank doesn’t control mortgage rates directly but when the cost of borrowing falls for banks they tend to pass on those savings in borrowing to the people they’re lending money.

Will the fallen price of oil affect housing affordability in B.C.?

Most likely. Everywhere in Western Canada is tied to the extraction economy and so when oil prices go down that’s bad for the wealth of the population, and when the wealth of the population falls, prices fall. And the falling loonie has a complicated effect on demand for housing. It lowers buying power at home – which could be good for exporters but bad for the real wealth of Canadians as we buy a lot in U.S. dollars. But many overseas investors won’t be hurt by oil price declines, so their buying power may rise relative to Canadians’.